1. Review of financial, economic and monetary developments and policy options
Financial market developments
Mr Cœuré reviewed the latest financial market developments.
Since the Governing Council’s previous monetary policy meeting on 25-26 April 2018, global bond markets had seen an increase in risk aversion, amid rising geopolitical tensions and political uncertainty, which was accompanied by some credit spread widening and a temporary increase in market volatility. Trade tensions had escalated further in the global economy, with some emerging market economies having come under pressure.
The impact of trade issues on global financial markets had been visible in the reaction of equity markets to the announcements by the US Administration to initiate a Section 232 investigation into auto imports and to move ahead with tariffs on aluminium and steel imports from Canada, Mexico and the European Union, ending a two-month exemption period. Nevertheless, stock markets in some jurisdictions had increased since late April, in part reflecting incoming data that confirmed solid economic growth.
Following the April meeting, monetary policy expectations had evolved in a number of jurisdictions, including the euro area. With regard to the ECB, market participants’ expectations for a first rate increase had been pushed out in time somewhat. Looking at global interest rate differentials, the spread between two-year US Treasuries and their German equivalent had increased to over 300 basis points in May, its widest since July 1997.
In the euro area government bond markets, lower-rated jurisdictions’ sovereign bond yields had increased measurably towards the end of May, amid heightened market volatility, but in most jurisdictions yields had reversed large parts of their initial rise over the following two weeks. The German ten-year government bond yield had fallen on the back of flight-to-safety investment flows. Funding conditions for euro area banks and non-banks remained favourable overall.
In foreign exchange markets, the euro had depreciated against the US dollar, effectively reversing the strong appreciation observed earlier in the year. All in all, this period had coincided with a general strengthening of the US dollar, not only against the euro, reportedly explained by cyclical divergence between the United States and the rest of the G10, changes in relative equity performance and widening short-term interest rate differentials. Mr Cœuré concluded his introduction by recalling that changes in funding conditions in US dollars had been a very significant development at the end of 2017 and into 2018, but that the LIBOR-OIS spread had been narrowing more recently.
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